Oil & Gas: Transportation agreements- complexities in transition to cost-share pricing

In Teesside Gas Transportation Limited (‘TGTL’) v (1) CATS North Sea Limited; (2) Antin CATS Limited; (3) ConocoPhillips Petroleum Company U.K. Limited; and (4) ENI UK Limited [2020] EWCA Civ 503 (the Defendants collectively referred to as ‘the CATS Parties’) the Court of Appeal decided a key aspect of the working of a cost-share regime under a transportation and processing agreement. In doing so, it highlighted the complexity associated in drafting and operating cost-share regimes that are negotiated many years before they take effect.

Facts

The Central Area Transmission System (known as ‘CATS’) is a natural gas transportation and processing system that transports gas from the Central North Sea to a processing terminal at Teesside.

The CATS Riser Platform is owned and operated by the CATS Parties. The CATS Riser Platform is linked, by a bridge, to a production platform, not owned by the CATS Parties, namely the North Everest platform. A 404km high-pressure gas pipeline (the ‘CATS Pipeline’) runs from the CATS Riser Platform to an onshore redelivery terminal and gas processing plant (collectively, the ‘CATS Terminal’) at Teesside. Several production fields in the North Sea are linked to the CATS Pipeline, delivering gas to it either directly or through a series of connections at the CATS Riser Platform. Since becoming operational in 1993, the CATS Pipeline has been one of six principal pipelines delivering North Sea gas to the UK mainland.

On 10 September 1990, the TGTL, as shipper, and the predecessors of the CATS Parties, as owners, entered into a Capacity Reservation and Transportation Agreement (‘CRTA’). Under the CRTA, TGTL was entitled to a pre-determined capacity of pipeline gas, through the exclusive use of specified points of entry (for gas entering the system) and exit (the redelivery of the gas from the transportation facilities into the processing facilities). The effect of this was to grant TGTL ‘a pipeline within a pipeline’.

The central issue in dispute was the amount payable by TGTL to the CATS Parties under the CRTA. The CRTA provided for two different payment regimes:

1. From April 1993 (when the CATS System became operational) until 1 October 2013, TGTL paid a fixed ‘Transportation Fee’. That fee was not in issue in these proceedings.
2. From 1 October 2013 to 1 October 2018 (being the end-date of the CRTA), TGTL was to pay a non-fixed ‘Capacity Fee’. That fee was to be calculated pursuant to a contractual formula, which was at the heart of this dispute.

A dispute arose in relation to the calculation of the Capacity Fee, which operated from October 2013.

Under the CRTA, the Capacity Fee was calculated as follows:

[Capacity Fee] = ([Capacity Reservation Rates] / [CATS Capacities]) ([Operating Expenditures] + [Extraordinary Operating Expenditures] + [Capital Expenditures]) (1.15)

In this respect:

1. The Capacity Fee was the fee payable for the Contract Year in question. (A “Contract Year” ran from 6 a.m. on 1 October to 6 a.m. on 1 October of the following calendar year).
2. Capacity Reservation Rate was the amount of gas reserved by TGTL, defined as “an amount equal to the sum of the Capacity Reservation Rates (expressed in Cubic Metres per Day) applicable on each Day of the Contract Year in question …”. The Capacity Reservation Rate was stated to be 8,334,900 Cubic Metres per Day. TGTL was entitled to reduce the Capacity Reservation Rate on giving two years' prior notice, but only with effect from 1 October 2008. Any reduction could not be reversed. In the event the Capacity Reservation Rate was reduced for the 2017-18 Contract Year to 6,515,000 Cubic Metres per Day.
3. CATS Capacities was “an amount equal to the sum of the CATS Capacities (expressed in Cubic Metres per Day) applicable on each Day of the Contract Year in question”. The term “CATS Capacity” was defined as “the summation of the Capacity Reservation Rate and the aggregate maximum rates of delivery of Non-Capacity Gas notified by the CATS Operator pursuant to Clause 4.6(a)(vii), subject to any changes notified pursuant to Clause 4.6(b)(i)”. (emphasis added)

Clause 4.6(a) provided as follows:

“In the event that the CATS parties have contracted the use of the CATS Transportation Facilities for Non-Capacity Gas, the CATS Operator shall promptly, subject to the provisions of clause 24.4, give [TGTL] a notice containing the following information:

(i) the field from which such Non-Capacity Gas shall be produced and the facilities from which such Non-Capacity Gas will be metered and delivered to the CATS Transportation Facilities;

(ii) the proposed point of delivery of such Non-Capacity Gas into the CATS Transportation Facilities;

(iii) the proposed point at which such Non-Capacity Gas is to be re-delivered from the CATS Transportation Facilities;

(iv) the date on which the transportation of such Non-Capacity Gas is proposed to commence;

(v) the estimated date on which the transportation of such Non-Capacity Gas is proposed to terminate;

(vi) the specification in a format to be agreed of such Non-Capacity Gas at the point referred to in paragraph (ii) above together with a bona fide estimate of the composition of such Non-Capacity Gas during the proposed period of transportation of such Non-Capacity Gas;

(vii) the maximum rate of delivery of Non-Capacity Gas at such point during the proposed period of transportation; and

(viii) the bona fide but non-binding estimate of the aggregate quantity and composition of Non-Capacity Gas (including Non-Capacity Gas under the contract the subject of the notice under this Clause 4.6(a)) to be delivered to the CATS Transportation Facilities for each Month of the current and each of the next 5 Contract Years and for each Quarter during the remaining term of this Agreement.” (emphasis added)

As originally agreed in 1990, clause 4.6(b) provided:

“No less frequently than Quarterly, the CATS Operator shall, subject to the provisions of Clause 24.4, give [TGTL] a notice containing the following information:

(i) any changes in the information previously provided pursuant to Clause 4.6(a); and

(ii) the CATS Capacity for the ensuing Contract Year.” (emphasis added)

This clause was amended on 14 September 1998 by deleting the words “No less frequently than Quarterly” and replacing them with “From time to time upon receipt of a request from [TGTL], which requests may be made on no more than one occasion in each Quarter”.

The issue in dispute was whether, for the purpose of the Capacity Fee formula, the relevant figure for each third party shipper, was (a) the maximum rate of delivery by that shipper over the whole period covered by its contract with the CATS Parties or (b) a figure (known as the Daily Reserved Capacity Rate, or ‘DRCR’) agreed from time to time between the CATS Parties and the third party shipper as that shipper’s firm booked capacity in the pipeline.

TGTL contended for the former (and higher) figure; the CATS Parties contended (and the judge at first instance concluded) that the latter (and lower) figure is correct. The value of the difference was some £37 million.

Court of Appeal Decision

The Court of Appeal decided that the correct approach in calculating the CATS Capacities was the DRCR agreed from time to time between the CATS Parties and the third party shipper as that shipper’s firm booked capacity in the pipeline. It was not the maximum rate of delivery by that shipper over the whole period covered by its contract with the CATS Parties, as TGTL contended.

In deciding for the CATS Parties, the Court of Appeal considered that:

1. The clause in question was capable of more than one interpretation.
2. In favour of TGTL interpretation: There are strong linguistic grounds for thinking that “the proposed period of transportation” pursuant to Clause 4.6(a)(vii) must refer to the period between “the date on which the transportation … is proposed to commence” and “the estimated date on which [it] is proposed to terminate” referred to in Clause 4.6(a)(iv) and (v). That interpretation is consistent with the language of the clause and no other “proposed period of transportation” is referred to in Clause 4.6. Therefore, focusing on Clause 4.6(a)(vii) in isolation, suggests the maximum rate means that rate which will apply at any time during the period covered by the Transportation & Processing Agreements with third party shippers (‘TPAs’).
3. Against TGTL interpretation: However, when Clause 4.6 is viewed as a whole, the position is less straightforward. Clause 4.6(b) provides for updated information to be provided. This had to be done at least quarterly under the terms originally agreed in 1990. The provision for changes to be notified does not exclude “the maximum rate of delivery” referred to in Clause 4.6(a)(vii) and thus appears to contemplate that this figure may change, and may do so often. That seems inconsistent with TGTL’s case.
4. The requirement for quarterly notification of the “CATS Capacity” meant that the “CATS Capacity” was liable to change throughout the period of the CRTA. The Capacity Reservation Rate component of “CATS Capacity” either would not change or, if it did, TGTL would already know about the change. The changes to “CATS Capacity” contemplated by the clause about which TGTL needed to be notified must therefore refer to changes in the maximum rates notified under Clause 4.6(a)(vii). While it can be accepted that the “CATS Capacity” figure would increase during the early years of the CRTA as new contracts were concluded with third party shippers, this would be a finite process due to the limited number of gas fields physically capable of connecting to the pipeline. Any suggestion that quarterly changes would or might continue throughout the period of the Agreement seems inconsistent with TGTL’s case.
5. It was necessary to construe the CRTA as a whole. Amongst other things, in that context:
   1. Booking Capacity: The same language (“the maximum rate of delivery of Non-Capacity Gas notified by the CATS Operator pursuant to Clause 4.6(a)(vii) of the Agreement”) was also used in Schedule XIII as part of the definition of “Booked Capacity”. The concept of Booked Capacity is likely to provide a good insight into what the parties meant by the “maximum rate” referred to in Clause 4.6(a)(vii).
   2. In the context of Schedule XIII (dealing with allocation principles) it was clear that Booked Capacity referred to the capacity actually reserved (or booked) from time to time. Historical maximum figures would have no relationship with what was actually being shipped at any given time (or, if different, with capacity which was actually booked) and could be of no relevance to the allocation exercise with which Schedule XIII was concerned. Indeed, the use of historical figures would make it impossible for allocation to be carried out “on a basis that is demonstrably fair and equitable to all CATS Fields” as required by that Schedule.
   3. Emergencies: Clause 12 of the CRTA dealt with emergency situations leading to a reduction in capacity. It provided for the capacity which remained physically available to be allocated between the users of the pipeline, distinguishing between the first 36 hours of any period of reduced capacity and continuing reduction thereafter. In the event that the reduction continued beyond the initial period, clause 12(b)(ii) provided that: “the Capacity Users shall in aggregate be entitled to a portion of the Available Capacity equal to the proportion which the Capacity Reservation Rate bears to the CATS Capacity.”. It is obvious that this provision was intended to effect a fair sharing of the available capacity between the users of the pipeline affected by the reduction. That objective would be achieved if the CATS Parties’ construction of “CATS Capacity” was correct, but not if TGTL is correct in its submission that third party shippers' contribution to the ascertainment of “CATS Capacity” depended on historic and out of date maximum rates which (as time went by) were likely to be far in excess of capacity which those shippers had actually booked at the relevant time.
   4. Spare Capacity: Clause 16 allowed Parties a substitution right to take “spare capacity in the CATS Capacity”. The existence of spare capacity rendering substitution a possibility was to be determined by reference to “CATS Capacity”. This could only sensibly be done on the basis that “CATS Capacity” refers to up-to-date figures for booked capacity. An assessment done by reference to historic figures would be meaningless.

The CATS Parties’ construction also makes far better commercial sense. It accords, with what the parties would sensibly be expected to have agreed, although (as the judge also made plain) that expectation is no substitute for analysis of the contract terms. A construction of “CATS Capacity” which results (as TGTL’s construction does) in a figure substantially in excess of the actual capacity of the pipeline and far in excess of the usage of the pipeline which would have been expected during the final years of the CRTA when the Capacity Fee was payable makes very little sense.

While there was considerable force in TGTL’s proposed construction if the focus is confined to the terms of Clause 4.6(a)(vii) itself, the position is more nuanced if Clause 4.6 is considered as a whole. However, when the CRTA is construed as a whole and is seen in its commercial setting, the true construction of the clauses relevant to this dispute is reasonably clear. The CATS Parties’ construction of the Capacity Fee provision makes better sense of the contract and was preferred.

Comment

Transportation and processing agreements remain amongst the most complex of oil and gas contracts. As such, it is perhaps not surprising that the calculation of the Capacity Fee gave rise to a number of disputes in the Commercial Court under the CRTA, one of which was appealed to the Court of Appeal.

The fact that transportation and processing agreements are drafted, and agreed, to endure over significant periods of time poses special challenges to drafters seeking to deal with events that might occur 20 years hence. The shift from a tariff-based mechanism to cost share is a regular source of disputes over the categorising of costs. Many agreements provide limited guidance on the operation of the cost-share phase, which is often far from the parties’ immediate concerns at the time the agreement is negotiated and executed.

However, for drafters of such agreements and those operating them on a day-to-day basis, the decision of the Court of Appeal seems to provide some useful guidance:

1. The Court of Appeal emphasised the importance of construing the contract as a whole.
2. In negotiating transportation and processing agreements, there are numerous moving parts of the draft agreement that are (often) being worked on in parallel by sub-teams. It is important that the concepts and terms being used by these sub-teams align in the final executed agreement. Here the term “CATS Capacity” was used throughout the agreement in relation to, amongst other things, pricing, provision of services on emergencies and substitution rights. The Court of Appeal favoured an interpretation of the agreement that allowed the terms used to have a consistent meaning and application. This emphasises the importance of ‘joined-up’ drafting across sub-teams dealing with interlocking and interdependent defined terms.
3. At the time many legacy transportation and processing agreements were drafted, little thought was given to the operation of cost-share mechanisms. As with the CRTA, most cost-share regimes will not apply until approximately 20 years into the operation of the agreement. The first 20 years (or so) will be governed by an agreed tariff. As a result, the cost-share mechanisms were not an immediate priority at the time of drafting. That lack of prioritisation is now resulting in various disputes concerning the interpretation and operation of provisions that were not necessarily drafted in a foolproof manner. Two consequences are:
   1. First, caution should be exercised in modelling cost-share elements of new transportation and processing agreements on existing precedents. Many of those precedents are drafted in terms that are not straightforward to interpret and have resulted in disagreements between parties.
   2. Second, the entry of infrastructure funds and other new entrants into the ownership of transportation and processing assets has changed the commercial dynamic in the operation of those assets. While traditional ‘large-cap’ oil and gas companies may not historically have seen these assets as separate profit centres, but as a means to monetising hydrocarbons won, infrastructure funds and many other new entrants have invested in them as profit centres. As such, it can be anticipated that infrastructure funds, and many other new investors, will analyse existing agreements to ensure they are being operated in a manner to maximise their return on that asset – resulting in a potential for disputes – even if this is not consistent with the approach pre-existing parties have taken to date.

Commercial Court Judge: Butcher J

Court of Appeal: Sir Geoffrey Vos, C.; Males L.J.; Newey L.J.